While wreaking its
unbelievable destruction, last quarter’s financial-market panic
certainly showed no favoritism. Launching from ground zero in the
financial stocks, shockwaves of selling blasted out through the
entire market landscape. Everything speculators once loved was left
in ruins, including silver.

Back in July 2008
when the financial markets remained oblivious to the tsunami of fear
approaching, silver averaged $18.07 on close. But by November when
popular stock-market fear reached a fever pitch, silver only
averaged $9.81. A 45.7% loss on the monthly averages, not merely
the extremes, in just 4 months was enough to test the faith of even
the most dedicated long-term silver bull.

But even at the
very bottom when things looked the bleakest, it was clear silver’s
extreme lows were anomalous and not sustainable. The day after
silver’s $8.92 closing nadir on November 20th (not coincidently the
very day the general stock markets bottomed too), I published an
essay called “Silver
in Crisis”. The conclusion was silver’s selling was way
overdone. So we were buying ridiculously-oversold silver stocks at
the time.

One new long-term
elite silver-stock investment we made in
Zeal Intelligence
in November in the heart of the panic was already up 81.9% as of
this week. It pays big to be a contrarian and be brave when
everyone else is afraid. Indeed, since those depths silver has
strengthened considerably. Over the past week it has averaged
$12.46, 34.1% higher than its average $9.29 close in the week
leading to its panic low.

This impressive
run in silver has led some traders to wonder whether it is getting
overbought and the short-term risk-reward equation is
shifting out of its favor. With a good fraction of my own capital
deployed in physical silver and various silver stocks, silver’s
near-term outlook intrigues me too. Of course I am very bullish on
silver in a secular sense, but after my research this week I’m
bullish on the coming months too.

Despite all
silver’s own fundamental merits, its primary technical driver is
nearly always the price of gold. In a favorable gold-price
environment, speculators’ interest in all the precious metals
grows. So they deploy increasing amounts of capital in silver. In
this tiny market, it doesn’t take much buying (relative to larger
markets) to drive big and fast price spikes. And when gold is weak,
silver speculators lose interest fast.

This
gold-driving-silver dynamic remains controversial among some silver
investors, but it certainly shouldn’t be. In 2007 I did a study
encompassing decades’ worth of big silver uplegs/bulls and
the resulting
charts are crystal clear. Silver generally lags gold initially,
but as gold gathers steam speculators flock to silver and ignite the
sharp moves higher this restless metal is so famous for. Gold leads
the way.

In recent years
this centuries-old positive correlation of silver with gold
continued. This first chart compares the raw silver and gold prices
over the last 4 years or so. Note that these vertical axes are both
zeroed, so there is no scale-induced visual distortion of this
critical relationship. Prior to the financial panic in late 2008,
silver indeed maintained a very tight correlation with the gold
price.

The bullish
ascents of the blue silver line and red gold line in recent years
are very similar. In fact you could probably pass one off for the
other if there were no price labels on the vertical axes. And this
close relationship is not just visual, but statistical. Between
January 2005 and August 2008 (a secular pre-panic span), the daily
correlation r-square between the silver price and gold price ran
94.7%. In other words, nearly 95% of the daily price action in
silver was mathematically explainable by gold’s own.

But during the
stock panic, silver suddenly radically decoupled from gold. Gold
was fairly resilient through this fear bubble, but silver just
plummeted. While the yellow metal merely hit a 14-month low at
worst, silver spiraled down to a horrific 34-month low. It was
trading way back at early-2006 levels before the dust settled and
its price started stabilizing. This fascinating decoupling is
actually the basis for silver’s near-term bullish thesis today.

During the
stock-panic months (September to December), silver’s correlation
r-square to gold plunged to 52.5%. Only about half of silver’s
daily price action was statistically explainable by gold’s. This is
still based off a positive correlation, but a much weaker one than
we typically observe in silver. It wasn’t necessarily this weaker
correlation that caused silver’s problem, but its newfound mid-panic
asymmetry. The correlation grew lopsided to the downside.

On most days
during the panic months when gold was up, silver would rise too.
But usually it would just pace gold’s gains at best, and sometimes
not even match them. But on days when gold was down, silver would
often plunge dramatically and multiply gold’s losses. Playing out
over months, this outsized downside pressure on silver whenever gold
was weak led to the serious decoupling evident in this chart.

Why was silver so
much weaker than gold during the financial panic? Silver’s price is
much more dependent on sentiment at any given time than gold’s. And
sentiment during the panic was exceedingly rotten. Speculators sold
everything universally, sparing nothing. The riskier any particular
asset, the more aggressively it was liquidated to raise precious
cash and to protect from the threat of further losses.

Silver is a
speculators’ playground in the best of times, a very exciting and
hyper-volatile precious metal. But in the worst of times, the stock
panic, silver’s very attributes that usually work for it suddenly
conspired against it. As a tiny market easily blown about by
relatively small shifts in capital flows, unlike gold it wasn’t big
enough to decently weather the intense fear-driven selling. And of
course the farther it plunged, the more selling it sparked. As its
price crumbled, anxiety soared even among its biggest fans.

By the time the
panic-driven sentiment storm started to abate, silver was far lower
than the gold price suggested it should be. It was extreme fear
that drove this silver anomaly, and this extreme fear was driven by
a global stock panic. Not only is that panic over today, but
general fear and anxiety in the markets have been abating
continually since late November. And with no more extreme fear to
hold it down, shouldn’t silver recover to historical norms relative
to the gold price?

I not only think
it will, but I am betting on it. A relationship that has been
demonstrably very strong
for decades,
and has actually existed for centuries, probably can’t be totally
wiped away by a fleeting fear bubble lasting a few short months.
Silver is highly likely to mean revert to its long-time relationship
with gold. We can nicely quantify all this with the Silver/Gold
Ratio, which the next chart explores.

Technically the
SGR is the silver price divided by the gold price. Unfortunately
this leads to tiny numbers that I have a hard time wrapping my
little brain around. At $12 silver and $900 gold, the true SGR is
0.0133. I charted this and unfortunately it really isn’t very
intuitive. This is the same reason currencies with low values (like
the yen) are quoted differently in forex markets than currencies
with high values.

So I decided to
use an easier-to-digest proxy for the SGR, the inverse of the
silver/gold ratio. At $900 gold and $12 silver, this is 75. An
ounce of silver is worth 1/75th an ounce of gold. To make this SGR
proxy properly reflect silver strength and weakness, I had to invert
its axis. A falling SGR means silver is getting weaker relative to
gold and vice versa. This resulting chart is very interesting.

During the 44
months leading up to the Great Stock Panic of 2008, silver averaged
1/55th the price of gold (I’ll just use this number rather than the
fraction from here on out). This pre-panic 54.9 average was fairly
tight too. It wasn’t defined by a few rare extremes, but many years
of gentle meandering near the middle of a range between 65 and 45.
Despite the countless market-moving gold and silver developments
since 2005, this 55 average held nicely.

Incidentally, if
you do any deep silver-stock or gold-stock research, the miners will
often report equivalent numbers. A primary silver miner will take
its byproduct gold production and convert it into silver ounces
using the cash equivalent. A primary gold miner will do the
opposite, converting its byproduct silver into the cash equivalent
of gold ounces. In countless SEC reports I’ve waded through of gold
and silver miners, this 55 ratio is usually the number they all use
for equivalent calculations. It is well-established.

And over recent
years, the variance in the SGR has actually decreased considerably
as you can see above in the tightening wedge. All this leads me to
believe that an SGR near 55 is far more normal for this bull market
than the levels seen during the stock panic. As speculators fled
everything including silver, its price plunged far more than
gold’s. This drove the SGR to its lowest levels of these entire
precious-metals bulls.

It was the
plunging stock
markets that drove this extreme universal fear. So
silver fell to its lowest level relative to gold on November 20th,
the very day the S&P 500 swooned to its lowest close of the panic by
far. That day, silver at $8.92 was only worth 1/84th of the price
of gold at $745! I had never imagined such a low SGR was even
possible prior to that panic, and I am certainly not the only silver
investor who was surprised by it. The panic blew apart all kinds of
previously unassailable historical relationships.

And incredibly
such an extreme wasn’t just a single-day anomaly. During the entire
panic (September to December), the SGR averaged 75.8. This is just
ridiculously low relative to silver’s history with gold. Gold was
actually being bid up mid-panic as investors recognized that its
performance was really quite good compared to nearly every other
asset during the panic. But speculators, quaking in fear, refused
to return to silver as readily as the gold investors returned to
gold.

For a variety of
reasons, I fully expect silver’s historic relationship with gold to
normalize. It has existed for so long that a fear bubble in the
stock markets lasting a few months shouldn’t be able to sever it
forever. Nothing fundamentally changed on the silver or gold mining
fronts during the stock panic, so the secular-bull pictures for both
metals look similar today as they did back in July. And silver
speculators will always be interested in the much larger gold market
and watch it for clues on how to bet on silver.

At $900 gold and a
normal historical 55 SGR, silver should be trading near $16.36
today. This is 30.8% higher than it was trading in the middle of
this week! So even if gold does nothing, a simple mean reversion in
the SGR to pre-panic levels implies a silver price much higher than
today’s still-depressed levels. Until silver returns closer to its
normal range relative to gold, the short-term case for this white
metal remains very bullish.

And interestingly
there are a few factors that make silver’s near-term potential look
far more bullish than this simple mean reversion to reflect today’s
prevailing gold prices implies. The first is gold’s own bullish
fundamental outlook. The second is the strong tendency in financial
markets for extremes in one direction to rebound with such momentum
that they overshoot into the opposite extreme before normal
relationships are reestablished. And the third is the way most
silver is mined today, as a byproduct.

For many reasons I
outlined in an essay in late December,
gold’s
fundamentals are awesomely bullish. Its price is likely to rise
substantially to dramatically in 2009. I can’t imagine not seeing
at least a 20% gain in this calendar year. So a mean reversion of
the SGR to today’s gold prices is conservative. If we indeed
see gold power higher this year, then the usual 55 ratio implies an
even higher silver price to reflect it. As an added bonus, a rising
gold price will entice speculators back into silver much more
rapidly than a flat one.

And while I am
more cautious on this secondary factor, I think it is fair to
mention it. Extremes in the financial markets are driven by
sentiment, a great pendulum of popular consensus swinging from greed
to fear and back again. This pendulum almost never gets pulled to
extremes in one direction, starts swinging back to recover, and then
simply stops dead mid-swing at normal levels. Its momentum usually
carries it well through normal to the opposite direction. Applied
to the SGR, this means we could very easily see a temporary spike
well under 55.

At $900 gold and a
40 SGR, silver would easily exceed its March 2008 bull high to trade
above $22 in a greed spike. And if you run the math for a higher
gold price or better SGR, it gets even more bullish. But realize
this reversion thesis certainly doesn’t need either a higher gold
price nor an outsized oscillation of the SGR to the other extreme.
It is plenty bullish for silver even if gold stays flat and the
ratio merely returns to normal.

A true fundamental
factor spawned by the panic could play a role too, and it is very
bullish for silver. Something like 3/4ths of all the silver mined
worldwide is merely a byproduct, primarily of base-metals mining.
And the base
metals’ prices were obliterated in the fear that surrounded the
stock panic, plunging by more in a few months than they fell in the
entire Great Depression in some cases. If base-metals miners
respond to this crisis by mothballing mines or reducing production,
the mined silver supply could fall as well. Less silver for
speculators to chase means higher prices sooner.

In light of all
this, a really compelling bullish case can be made for silver over
the near term. We’ve been trading accordingly in our subscription
newsletters, recommending various silver trades that should thrive
as the silver price returns closer to its historical relationship
with the gold price. Unless gold plunges, which is very unlikely in
today’s
inflationary world, the silver price needs to go higher
regardless of any other factors.

In the new
February issue of our acclaimed
Zeal Intelligence
monthly newsletter, I recommended a silver stock that big capital
will flood into as the silver price normalizes with gold’s. And as
always, it is full of deep, insightful, and actionable contrarian
financial-market analysis that you can’t find anywhere else.
Fortunes will be made emerging from these panic anomalies, so
subscribe today
so you don’t miss out on the coming gains.

The bottom line is
silver’s primary driver is the price of gold. But general fear grew
so intense in the sentiment firestorm of the stock panic that silver
radically decoupled from gold. It was driven to incredible lows
that are unlikely to persist as fear abates and the financial
markets return to normal. As speculators slowly emerge out of their
fear-induced stupor, they will return to silver and other
speculative assets.

So almost
regardless of what happens anywhere else, the silver price should
gravitate towards more normal levels relative to gold. Even if gold
stays flat and silver merely returns to its average ratio with gold,
this white metal still has excellent near-term appreciation
potential. And of course the best silver producers’ stocks should
nicely leverage any silver gains driven by its mean reversion to
normalcy with gold.